Control of subsidised FTTH will bring structural separation to Telecom NZ

New Zealand is getting closer to its ultra-fast broadband dream. The government issued a 'draft proposal for comment', basically to set up a PPP for constructing the network.

As promised earlier, the government will contribute half of the cost (NZD 1.5bn) of building out an open access FTTH network to 75% of the people (in 25 towns - note that 29.5% of all homes are in Auckland). During the first six years, focus is on schools, businesses, the health industry and greenfields. However, FTTH must be deployed within 10 years.

The big issue of course is: what will Telecom NZ do? Will they overplay their hand the way Telstra did in Australia? The document clearly demands structural separation of Telecom NZ, should it want to invest in the passive infrastructure; unless it would hold a minority stake (comparable to KPN holding 41% in the new Reggefiber Group), in which case functional separation (which it already implemented) would suffice. In other words: if Telecom NZ steps in with a minority share, it wouldn't have to change its structure, but (unlike KPN) it would need to be structurally separated once it would gain a majority stake in any LFC.

Here are the Key Principles from the document:

• making a significant contribution to economic growth;
• neither discouraging, nor substituting for, private sector investment;
• avoiding entrenching the position, or ‘lining the pockets’, of existing broadband network providers;
• avoiding excessive infrastructure duplication;
• focussing on building new infrastructure, and not unduly preserving the ‘legacy assets’ of the past;
• ensuring affordable broadband services.

Here are some conditions:

• The vehicle for investing the subsidy will be crown-owned: Crown Fibre Investment Co (CFIC). It will invest, alongside co-investors, in Local Fibre Cos (LFCs). CFIC will hold up to 50% of the shares of the LFCs.
• "Selection criteria will be focused on several aspects – the amount of additional fibre coverage being proposed, the proposed capital structure (including the parties’ relative capital contribution requirements), the commercial viability of the proposal, consistency with government objectives, and the track-record of the partner."
• "The government’s shareholding may be concessionary, and in particular may be subject to a lower rate of return than the partner for an initial period (for example, up to ten years). These provisions will be negotiable."
• "LFCs will not provide retail services. However, the government will not exclude partners that own or operate telecommunications retail operations, but such partners may not have the majority of voting control on the board of LFC (unless they divest themselves of any retail business). Telecom, and other telecommunications operators with retail operations, will therefore be able to participate in the contestable selection process, subject to the above requirement."

And here are some more details:

Time line

Comments due end of April, report back to the government end of May, appointmnet of the vehicle mid June, RfP to be released mid August, proposals due mid October, initial decisions due January 2010. All submissions, due April 27, will be published at www.med.govt.nz/broadband.

Wholesale

The network owner will primarily sell dark fiber, and "potentially other approved wholesale broadband services. (...) LFC may: provide a wholesale bitstream service; and enable the provision of interim solutions by wholesale customers, such as wireless last mile or ADSL2+ or VDSL2 solutions, provided that this is consistent with the LFCs achieving the government’s objective of FTTH within ten years; and subject to the CFIC’s approval, provide any other wholesale broadband service."

"The government investment will be in fibre networks that will operate only at the wholesale level, selling dark fibre based services enabling telecommunications providers to design and specify their own downstream services. This approach will ensure that all decisions regarding active network technology options are left to private sector investors."

"By keeping the new fibre business out of retailing, it will have no incentives to act anti-competitively, and there will be little need for regulation of its prices. In fact, there will be considerable initial incentives for it to keep the fibre rental prices low to facilitate use by downstream providers."

"The new network will provide dark fibre services to any ISP or telecommunications service provider, and will operate as an infrastructure ‘utility’ at the passive level of the market. The aim is to provide a new fibre platform upon which service providers can develop their own services and create unique, innovative offerings."

Services

The usual suspects are there, including: "There is also a strong likelihood of new applications being developed in the future that will require residential users to have fibre broadband connections to operate them effectively, particularly as increasing numbers of services are delivered digitally."

FTTH: Axia NetMedia, separation, FTTN and SLU

Three important developments this week in FTTH:

• Axia NetMedia (discussed before) detailed its plans for Australian NBN. If they have it their way, they will build FTTP, not FTTN.
• The same firm bids on the active layer of the Singapore network (NGNBBN), with Cisco. It's somewhat puzzling to see Axia bid alone (on the Australian NBN, but naturally they need partners), with SingTel (on the NGNBBN passive layer), or against SingTel but with Cisco (here). Maybe there's room to band together before contracts are signed.
• Swisscom has the revolutionary idea of laying 4 fibers to each home in its FTTH plans. It will use one itself, leaving room for three competitors to engage in infrastructure-based competition.

Plus: a worthwile interview. with TransACT's former CTO Paul Brooks. Question: "Telstra said it is 'impossible' to build or maintain a network if structural separation is enforced, is this true?" Answer: "No, of course not. They might not enjoy the same levels of cross-subsidisation they currently access regarding basic network infrastructure costs and high value-add retail products, but that's an economic argument, not an argument about whether it is possible or not. (...) If the wholesale arm actually had incentive to make things easy for their customers, then the business case for the separated retail arms becomes even stronger."

Plus: an Australian opposes sub-loop unbundling (SLU), but a New Zealander points to the reality of it, albeit it in FTTN + VDSL deployments.

FTTH is coming to New Zealand

Good times are coming to New Zealand. The National Party won last weekend's elections, so now the NZD 1.5bn plan to bring FTTH to 75% within 6 years is becoming a reality. The government will help to put together PPPs (public/private partnerships) to build an open access multi-layered network, in order to have maximum competition and "avoid excessive duplication of infrastructure". The government will launch a tender and Telecom NZ will participate.
To quote National's spokesman (and possibly the new Minister of ICT in John Key's cabinet) Maurice Williamson:

"... the government builds a road and everyone has the right to drive on it. Fibre optic is the road system of the 21^st century".

Will Telstra bid if it is structurally separated? Betcha!

Our fourth poll has ended, but to no obvious conclusion. A ridiculously small sample was heavily skewed toward structural separation (65%), but functional separation wasn't completely off the table (35%). Operational separation (5%) and accounting seperation (which you couldn't even vote for!) are excluded going forward.

The topic gets a lot of press these days, mostly in New Zealand, Australia and Italy. Check out this Arcep document for an introduction to separation.

Here is why we believe in structural separation.

• In a world of intramodal competition on the telco network (and intermodal competition between copper and coax) there will never be full equivalence between all players (incumbent, unbundlers, resellers, etc.). As much as PTT's want symmetry between telco and cableco competition (i.e. open access to cable networks), they should also allow for symmetry on the copper network. There will never be true symmetry if one service provider also owns the network, and the others don't. No matter what they say, the incumbent will always be at an advantage.
• Look at it from a synergy point of view. The incumbent reaps all the synergy benefits stemming from owning both the network and a service provider. These advantages should be equal and shared. And hence, all incumbents cry foul when confronted with the threat of being structurally separated. But that's the whole point, brothers and sisters: the regulator should focus on simply making PTT's smaller and creating long-term competition from viable altnets.
  
• KPN has successfully staved off structural separation. On the one hand, this is due to its full portfolio of wholesale services and a certain co-opetitive stance toward resellers. On the other hand, the world is facing next-generation access investments (i.e. FTTH), which are not only expensive (to be carried by a company the size of the incumbent only) but also create huge regulatory uncertainty. In the Netherlands, hardly anybody is left to consider serious and long-term competition (apart from cable). Orange Broadband is now owned by T-Mobile and put up for sale; bbned and its sisters can hardly be taken seriously because parent company Telecom Italia has a lot on its mind; and Tele2 seems to be withdrawing from western Europe altogether.
• Only when structurally separated can the telco appeal to the right investment communities: the dividend aficionados can buy the network, retail minded investors can focus on service providers (higher risk/return profile), etc. Also, only in this way can the network attract subsidies or create public/private partnerships. In a way Telstra acknowledges this: if it is structurally separated, it will not bid for the National Broadband Network contract and subsidy (AUD 4.7bn). But once separated, the network company will surely bid for the contract; I will eat my hat if it doens't!
  

We have looked very hard and closely at all the arguments against structural separation, but none really seems to make sense. Yes, it will be quite disruptive. And it will costs a few pennies. But to say that it would take away any incentive to invest just isn't very 21st century thinking. Finally, to say that you want to own the network (to generate the cash and allow you to pay fat dividends) is not very clever in light of the above (we want equivalence and symmetry, right?).

To round off, we want to share some fun related to the topic - unless it brings you to tears, of course.
Telecom Italia is one of those companies that may face structural separation and it will come as no surprise that Tiscali is all in favor. FastWeb takes a different position: they think it's a bad idea! Functional separation would suffice. But wait a second: isn't FastWeb 82% owned by Swisscom, another PTT?
With hindsight, that calls for a round of applause for Optus (the Australian subsidiary of SingTel). It openly called for structural separation of Telstra, even if it's parent company was fighting the same fate in Singapore. Or is it the other way around: was SingTel being a hypocrit?

Update on separation, FTTH and 3-D

Here's a short update on some of the hottest topics around:

• Separation. First of all, the Telecom New Zealand AGM rejected the election of the 'two Marks', put forward by Elliott International, to the board. They were in favor of structural separation, whereas Telecom right now focuses on operational separation and FTTN. A disappointing day, leaving the share price at a 16-year low ... However, good news related to functionally separated BT. The Register reports that it is considering outsourcing Openreach, putting the unit at an even longer arm's length. With Ben Verwaayen's departure to Alcatel-Lucent, it will come as no surprise that his new company could be a candidate for taking care of the job ... Finally, in Australia some people seem to be getting closer to structural separation as well, such as senator Minchin.
  
• FTTH. Julio Linares, COO of Telefonica, spoke at Broadband World Forum Europe. Here are some quotes from Total Telecom: "We will have to measure content in zetabytes. It is difficult to identify future services, but ultra-broadband will facilitate more video, high-definition and 3D content, and more. Consumers are going to need more bandwidth. Demand for bandwidth on fixed and mobile networks will multiply at least by five in the next three years. To support this zetabyte era, we are going to need new infrastructure, we are going to need networks. We need new technology, but technology is not going to be the constraint. Investment is the constraint. To build fixed broadband across Europe, we need to invest €250 billion, but at present the industry is averaging investment of €50 billion per year. It will take 20 years to build just the fixed part of the new infrastructure. Do you think we can afford it? (...) of course, no. (...) We need to speed up. At this time of economic crisis, it is very important to take into account the weight of our industry on the whole economy."
• 3-D. Philips has demonstrated 3-D VoD ('2D-plus-depth') at the IBC conference last month, branded WOWvx. It doesn't require special glasses, it's what they call an 'autostereoscopic display', basically consisting of an LCD display plus a lot of lenses covering the pixels. Both Deutsche Telekom and Orange have trialed the system. Even more recently, Philips showed its new Quad Full TV (thanks dear readers!), basically using the same technology but with everything brought together in a prototype TV.
  

Structural separation: spread the incumbent benefits

Very disruptive new regulation are coming to the telecom sector. Incumbents will suffer, both former PTTs and mobile operators.

Dominant operators are finally attacked. The synergistic benefits of running an integrated operator will be spread among all service providers.
The stranglehold that mobile operators hold on the market may end too.

Here are two of the most significant regulatory developments today.


1. Structural separation
In Australia and New Zealand several people call for structural separation of Telstra and Telecom NZ respectively.
Australia is preparing an NBN at the cost of AUD 4.7bn. At that price, it will probabaly be a FTTC network, but FTTH is still a possibility. It prompted opposition spokesman Bruce Billson to propose structural separation: "the natural monopoly that will be produced requires that kind of clarity".
Telstra retorted that structural separation "increases costs, reduces efficiencies, limits future innovation, and most importantly, kills off investment". Telecom NZ also resists.

I am very much in favor of structural separation on these grounds:

• It will be good for competition. One-time costs are something we'll have to live with.
  
• You bet it will reduce efficiencies that are linked to operating a vertically integrated monopoly that controls all three network layers (passive infrastructure, active infrastructure, services). Reducing efficiencies is not the purpose of introducing competition, but it is inevitable. There needs to be symmetry between all service providers on the telco network. Only then will there be true equivalence. Also: why should the incumbent be the only operator reaping all the synergetic benefits of integration? And don't forget: one of the main tasks of any NRA is to make the telco incumbent less dominant and hence: smaller! After many years of competition, these incumbents still dominate the market. Put differently: if the incumbent says it's bad for them, it must be good for the market!
  
• Innovation and investment theoretically suffer because the operator of the passive layer most likely would be a monopolist. However, I don't buy this argument, in our brave new co-opetitive world. Still, I suppose value-based management, regulation, incentive schemes and ownership structure of the passive layer could help solve the problem.
  

2. Bill and keep
British NRA Ofcom launched a consultation on the future of mobile communication (until November 6). Among the new regulations could be a move from termation charges (currently around 15% of mobile revenues) to a bill and keep regime (by 2011).
At about the same time, Vodafone released a report claiming that 40m Europeans would cancel their subscription if the sector moved to US style interconnection (i.e. bill & keep).

It has been stated before: lowering interconnection rates, or indeed moving to bill & keep, is meant to increase usage and lower prices. So how does Vodafone arrive at their claim of 40m people (10%) pushed out of the market? Could it be the way they structured their inquiry? "Suppose we would be forced to double our rates, because we would have to bill you for both making and receiving calls, would you still subscribe to our service?"
Or does Vodafone fundamentally disagree with the expected price elasticity? That seems odd, since mobile substitution still has a long way to go.
It remains to be seen how much pricing power mobile operators really have in the retail market. But it sure looks like they have to do another round of slimming down.
A different way to look at it is the fixed line alternative operator perspective. These operators look upon mobile termination as a subsidy for mobile operators building out their networks. Again, after so many years it is time to do away with this subsidy.

New Zealand: another Amsterdam look-alike

It didn't take the New Zealand Institute long to come up with an answer (April 2) to the question ("What investment vehicle", March 12) who should operate New Zealand's FTTH network. (In response, InterNZ calls for a debate.)


What it comes down to is a PPP (public private partnership) for a 3-layer model, that the Institute compares to the Amsterdam (Citynet) solution (page 9), which also seems to be coming to Singapore. Some questions remain, though (see below).


The highlights:

• FibreCo: a regulated monopoly "created by the government" charged with building an FTTP network covering 75% in 10 years time.
• "... because there is insufficient market value to build redundant fibre infrastructure and no technical reason to do so." (page 7) A peculiar way of defending this option. However (page 11) "... the value of fibre infrastructure will increase over time." This can be related to new services, rising demand and decreasing costs over time (page 15).
• Open access: FibreCo will have to rent dark fiber capacity on an equal basis.
• "Owners of existing (copper and fibre) networks can sell these assets to FibreCo on a commercial basis."
• Services based competition (page 20): "FibreCo works closely with appropriate companies to light the network and provide a range of services. (...) A single provider lights the network. May be provided by a service provider or an independent third party." This hooks in to current separation plans at Telecom NZ.
• Breakeven. Total cost of reaching 75% by 2018 is estimated to be NZD 4.0-5.0bn, of which two thirds for passive components and one third for active components (page 12). Assuming ARPU of NZD 50 per home (compared to current Telecom NZ ARPU of 80-100 NZD/mo/home) and other input, the breakeven cost per home is NZD 3,000 (page 13). The private sector would be expected to pay for such homes and the government would have to put up another NZD 1bn to cover homes that are more expensive to cover.
• Stimulating uptake: entry level service at a comparable cost; extended period of free services (here a reference is made to Nuenen in the Netherlands); require a switch from copper to fiber in order to be able to retire the copper wire (page 16).
• Stakeholders: government bodies (who will also be anchor tenants: today's annual spend on telecoms of NZD 200m will migrate completely) and private investors may contribute cash, existing operators contribute assets (existing fibre, ducting) and cash - all for a stake in FibreCo (page 18-19).
• Timeline. Operational separation is underway at Telecom NZ. Chorus, the network operator, should be priced within 12 months. Within another 6 months it should be sold to FibreCo (i.e. structural separation).

My take on this:

• Very much in line with my own preferred solution (single infrastructure, separation, 3 layers, open access).
• A focused, regulated, natural monopoly at the passive layer should be viable (page 11), even for a life at the stock exchange. Check out tollroad stocks (page 19) in Europe, which have done very well. It remains to be seen who the government will be able to attract as passive, private investors, but I am sure FibreCo will be an interesting vehicle for investors who prefer utility style investments. In case of emergency, would the government be ready to step and nationalize FibreCo?
• Chorus is to be sold to FibreCo, but at what price? This must be the toughest part to negotiate. The Institute says 'the value' will increase over time (see above) - whatever that means - so that assessment won't exactly help.
• Also, incumbent telcos are very much network focused, so they may oppose the idea of a monopoly operator. Doing operational separation is one thing, but structural separation may feel like another matter entirely to such a company.
• Some vertical integration would still be allowed (between the active layer operator and one of the the services providers). So, regulation should pertain to both the passive and the active layer, I suppose.
• Could some form of infrastructure based competition be possible by allowing more than one player at the active layer (transmission providers)?

New Zealand: what investment vehicle?

Earlier this month, the New Zealand Institute released another paper on broadband: The Need for Change. The call for FTTH becomes increasingly explicit. They stop short of calling for separation of Telecom New Zealand and providing government funding to the passive layer.

In an earlier report (September 2007), the benefits from increased productivity and growth (through telepresence) were calculated: 2.7-4.4bn NZD/year. Also, there is a cost to waiting. The institute proposed a 10 year roll out of FTTP for a 75% coverage.
In the meantime, Telecom New Zealand (TNZ) progressed on issues such as additional fibre (to cabinets, FTTC), LLU and separation (the government is to decide on the latest proposals by March 31).
Now, the Institute says these efforts are insufficient; the 75% coverage ratio would only be reached by 2040. Just a third of the benefits would be captured.

Approaching the FTTH issue from the financing side, they hit the nail on the head and come to some remarkable conclusions. Here are some (non-literal) quotes:

• Summary: Progress is too slow, the dominant investor has weak incentives to invest, a new regulatory and funding model for rapid roll out of fibre infrastructure is recommended.
• More specifically: TNZ needs higher returns than those provided by infrastructure assets like fibre. Besides, the company perceives a regulatory risk, demand is uncertain and there is capital market resistance to increased investment.
• Even more to the point: the cost of inaction is greater than the cost of action, even though both are value negative.
• A natural monopoly is much more difficult to regulate once multiple investors have invested in fibre and xDSL. ISPs/telcos will have increased investment in xDSL and will require a return before changing platform.
• The Institute recommends accelerated, efficient roll out of fibre infrastructure. This will require a new regulatory approach and investment vehicle. Investment in fibre infrastructure made by a third party that treats the investment as an infrastructure asset. Government intervention is the only viable option to accelerate roll out through a privately funded vehicle.
• The last question remains: What investment vehicle needs to be built?

Separation round-up

In March, the Dutch NRA (OPTA) declined to separate network and services at incumbent KPN. OPTA said it didn't have the power to do so. It added that cable competition, as well as open access to the KPN network (be it wholesale, LLU or bitstream) were sufficient to guarantee a competitive market.

However, Viviane Reding seems to be on collision course, aiming for a European effort at separating PTTs.

I suppose this issue will produce a lot of nois.

What has happened since?

• Italy seems most advanced, preparing a legal basis.
• New Zealand is pushing forward as well. In response, Telecom NZ has its own plans.
• Sweden has commissioned a report from its NRA, PTS, due June 15.